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Consulting 101

Many of my friends are asking me how to become a consultant. The conversation always starts out as “so how much do I charge?” To that, of course, I always answer “whatever you think that you are worth.” That answer usually gets me a troubled look and a little giggle. It wasn’t until recently that I finally got smart and decided to come up with a formula to determine a consultant’s hourly rate.

First you start with your current salary. If you divide that by 2000, which is the number of hours you work in a typical year, sans the 80 hours of vacation that you take each year. Also, 2000 is easier to use in division than 2080, so learn to deal with approximations and get on with consulting.

Now that you have a starting hourly rate, let’s talk about costs. First there are taxes for everyone. No matter what country you call home, you have to pay taxes. Remember that the figure you already computed is a pre-tax dollar amount, so don’t start adding in taxes to that rate. What you do need to incorporate is the employer side of your tax contribution. In the USA, we have a “social” tax of about 15%, which is split between the employee and employer. To this end, you would multiply your hourly rate by 1.075 to get your first adjusted rate.

Everyone gets medical insurance, right? That’s probably not true, so you better account for some medical insurance. You are your own product, so in the wise words of my friend Jerry B., “buy as much insurance as you can afford.” For a man, estimate your monthly medical insurance to be $150, which comes out to be about $0.80 per hour. This premium will increase along with your age, so round up your figure to $1 per hour. Now to recap:

HOURLY RATE = SALARY / 2000 * 1.075 + 1

You should always incorporate your business as a Subchapter-S Corporation. That way all of your income to the business will pass through to you at the end of the year and you don’t have to worry about double taxation on dividends. To incorporate, you can either get your best lawyer friend to setup shop for you, or visit http://www.corporate.com/ or http://www.mycorporation.com/. The price of incorporation should be less than $1,000, unless you have a lawyer do it for $3,000. Let’s say $1,000 is the price for incorporation, so that increases the hourly rate by $0.50.

Corporations have employees, and you are no exception. To that end, you need to setup a payroll service so that you don’t have to hassle with making quarterly tax payments to the government. I recommend a company named Paychex. They have very good pricing for the smaller professional services companies, like us consultants. With a payroll service, you pay for each issued check, or deposit, on a monthly basis. For a one-person shop doing direct deposit, you can expect to pay about $100 per month, or $1200 per year. That extra cost adds about $0.60 to your hourly rate. It’s time for another recap:

HOURLY RATE = SALARY / 2000 * 1.075 + 1 + 0.50 + 0.60
HOURLY RATE = SALARY / 2000 * 1.075 + 2.10

If you are setting up shop in the wonderful world of California, then you will have to pay $800 to the Franchise Tax Board every year. This is the cost of being a corporation in California. That $800 will boost your hourly rate another $0.40. Other states and countries will charge you even more money, especially if you are living in a socialist country. Just in case you were wondering, California doesn’t care if you are incorporated in Delaware, Nevada, or Timbuktu, as it will always charge you $800 to play in the California Economy. This $800 is a small amount of money to spend to get into one of the world’s largest economies.

Let’s talk about the benefits that you enjoy at your current employer’s behalf. There is vacation time, which is likely 80 or 160 hours per year. This is a small fraction of the total work time you spend, so it will not contribute no more than 10% of your bottom line. To that end, just multiply your hourly rate by 1.10 to get your vacation adjusted rate. Here is another recap:

HOURLY RATE = (SALARY / 2000 * 1.075 + 2.50) * 1.10

If you wanted to spend 25% of your time on vacation, or more, then your adjustment would be 1.25, or 1.35 for 35%, etc. This vacation adjustment is also a way to adjust for down-time. Don’t expect to work 2000 hours each year, unless you really want to wear yourself out. A down-time rate of 25% is typical in this business, so you should use an adjustment factor of 1.25.

HOURLY RATE = (SALARY / 2000 * 1.075 + 2.50) * 1.25

What other benefits do you have at your employer? How about a fitness club membership? That’s about $32 per month as an individual, or about $0.19 per hour. There are lots of other perks from your current employer, you just need to enumerate them on a yearly basis, and divide that amount by 2000 to get your rate adjustment.

HOURLY RATE = (SALARY/2000 * 1.075 + 2.50 + PERKS/2000) * 1.25

At this point, if you were at a job that pays $65,000 per year and included the fitness club and Starbucks Coffee each day, then your hourly rate should start at $47.85. That would give you the equivalent amount of purchasing power as your $65,000 per year job; give you three months of down-time reserve, and annual revenues of about $72,000.

What about your dream job? You’ve always wanted to be a big shot, raking in a bill or two per hour, right? So let’s see what happens when you want to make $112,000 per year. Your hourly rate would go to $80 and your revenues would be $119,141.

So what’s the big draw of making a high hourly rate? I’ve known consultants who charged as much as $1000 per hour for their time, and others as low as $4 per hour. Is there an optimal hourly rate that makes you comfortable? That’s ultimately up to you and how wisely you can manage your money. I’ve compiled a simple table of target salaries and their respective monthly cash money in the USA. How well you manage and spend money through your corporation will determine how much liquid cash you have each month.

Salary: $50,000
Rate: $37.77
Monthly Cash: $3,068.91

Salary: $75,000
Rate: $54.57
Monthly Cash: $3,887.98

Salary: $100,000
Rate: $71.37
Monthly Cash: $4,638.73

Salary: $120,000
Rate: $84.80
Monthly Cash: $5,512.16

Salary: $150,000
Rate: $104.96
Monthly Cash: $6,822.32

Salary: $200,000
Rate: $138.55
Monthly Cash: $8,139.96

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